UPDATE

Banks
India
Sector View: Attractive NIFTY-50: 21,659 January 05, 2024

PSU banks: Valuation convergence prompts a thesis review

The investment thesis of preferring Tier-2 PSU bank stocks has performed
well in the past year or so, driven by credit cost normalization. However,
valuation multiples have now converged sharply, prompting a review of our
recommendations. Given the relative strength of SBI as a franchise
(demonstrated over the last credit cycle), we now recommend owning it over
other PSU banks. We maintain BUY on SBI and ADD on BOB, but downgrade
Canara (ADD), Union (ADD) and PNB (REDUCE).

Investment thesis on credit cost normalization has played out well

Asset quality for PSU banks has seen a steady recovery in the past few years
toward the end of the corporate NPA cycle and even held up well through the
Covid pandemic – contrary to the expectations of many. This recovery cycle
began with a declining trend in slippages, which was followed by declining
GNPA ratios. We have now seen credit costs also decline as net NPA ratios for
most PSU banks have converged to a level of about 1.0%. The steady decline in
credit cost has driven a steady improvement in RoE closer to mid-teen levels.
With increasing comfort in the outlook for asset quality and return ratios, these
Tier-2 PSU bank stocks saw a sharp rally recently and their valuation multiples
have now converged closer to those of SBI, which traded at a valuation premium
for a few years. As a consequence, the investment thesis of favoring these
inexpensive stocks has played out very well.

Valuation convergence encourages us to favor the stronger franchise

With the recent swift convergence in valuation multiples, we have reviewed our
investment thesis on the PSU banking space. While we earlier favored holding
these Tier-2 PSU bank stocks, given the anticipated asset-quality recovery,
making an investment case for them is challenging unless we believe that Tier-
2 banks would be able to deliver superior return ratios for a much longer period,
led by a healthy differential in loan growth, superior revenue mix leading to
better operating profit ratios and importantly lower credit costs.

We do not think we have any evidence to change this thesis. SBI, in our view,
has demonstrated that its franchise has been better than other PSU banks
peers in terms of through-the-cycle credit cost, liability franchise, asset
franchise as well as digital/technological enhancements. Hence, we prefer to
now go back to recommending SBI over the other PSU banks.

Prefer SBI (retain BUY); downgrade PNB, Union and Canara Bank
We now recommend SBI (retain BUY) as our preferred stock within the PSU bank
space, while retaining ADD on BOB and downgrading the others – PNB (REDUCE),
Union Bank (ADD) and Canara Bank (ADD). We roll over our Fair Values to base
them on March 2026 BVPS while maintaining the same pecking order – SBI
(~1.2X), BOB (~1.0X) and the rest (Canara, Union and PNB) at ~0.9X.

Full sector coverage on KINSITE

M B Mahesh, CFA Nischint Chawathe Ashlesh Sonje, CFA Abhijeet Sakhare Varun Palacharla
mb.mahesh@kotak.com nischint.chawathe@kotak.com ashlesh.sonje@kotak.com abhijeet.sakhare@kotak.com varun.palacharla@kotak.com
+91-22-4336-0886 +91-22-4336-0887 +91-22-4336-0889 +91-22-4336-1240 +91-22-4336-0888

Sidham Jain
sidham.jain@kotak.com
 2

Changes in rating and Fair Value (FV) for PSU banks under coverage
Rating Fair Value (Rs) Target PBR (adj, X) Current PBR (adj, X)
Market price
Old New Old New (Rs) 2023 2024E 2025E 2026E 2023 2024E 2025E 2026E
Public banks
Bank of Baroda ADD ADD 215 250 238 1.5 1.3 1.2 1.0 1.4 1.2 1.1 1.0
Canara Bank BUY ADD 425 500 465 1.6 1.3 1.1 0.9 1.5 1.2 1.0 0.8
PNB BUY REDUCE 82 95 97 1.4 1.1 1.0 0.9 1.4 1.2 1.0 0.9
SBI BUY BUY 725 760 643 1.8 1.5 1.3 1.2 1.5 1.3 1.1 1.0
Union Bank BUY ADD 115 135 124 1.4 1.2 1.0 0.9 1.3 1.1 1.0 0.8

Note: We have shown standalone bank valuation multiples for SBI.

Source: Company, Bloomberg, Kotak Institutional Equities estimates

Valuation multiples of other PSU banks have converged with that of SBI recently
Price-to-book value (adjusted, 12-month forward) ratio for PSU banks (X)

SBI (core) BOB CBK UNBK PNB

2.5

2.0

1.5

1.0

0.5

-
Jan-11

Jan-13

Jan-15

Jan-17

Jan-19

Jan-21
Jan-10

Jan-12

Jan-14

Jan-16

Jan-18

Jan-20

Jan-22

Jan-23

Jan-24
Source: Company, Bloomberg, Kotak Institutional Equities estimates

Banks
India Research
 3

Peak GNPA ratio in the last decade was lower for SBI than other Net NPA declined more swiftly for SBI than other PSU banks
PSU banks
Net NPA ratio for PSU banks under coverage, March
Gross NPA ratio for PSU banks under coverage, fiscal year-ends (%)
March fiscal year-ends (%)
SBI BOB Canara Union PNB
12.5
SBI BOB Canara Union PNB
20
10.0
16
7.5
12
5.0
8
2.5
4

0.0

2QFY24
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
0
2QFY24
2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

Source: Company, Kotak Institutional Equities

Source: Company, Kotak Institutional Equities

SBI has consistently reported lower slippages than other PSU Average credit cost over the last decade has been lower for SBI
banks in the past few years as compared to other PSU banks
Slippage ratio for PSU banks under coverage, March Credit cost ratio for PSU banks under coverage,
fiscal year-ends (%) March fiscal year-ends (%)

SBI BOB Canara Union PNB SBI BOB Canara Union PNB
12.5 7.5

10.0 6.0

7.5 4.5

5.0 3.0

2.5 1.5

0.0 0.0
1HFY24

Average
2014

2017

2019
2020

2022
2013

2015
2016

2018

2021

2023
2QFY24
2012

2017
2018
2019
2013
2014
2015
2016

2020
2021
2022
2023

Source: Company, Kotak Institutional Equities Source: Company, Kotak Institutional Equities

Banks
India Research
 4

Other PSU banks have reported a higher cost of funds than SBI Other PSU banks have reported a lower CASA ratio than SBI
Cost of funds for PSU banks under coverage, March CASA deposit ratio for PSU banks under coverage,
fiscal year-ends (%) March fiscal year-ends (%)

SBI BOB Canara Union PNB SBI BOB Canara Union PNB
7.5 50

6.0 40

4.5 30

3.0 20

1.5 10

0.0 0

2QFY24
2013

2016

2018

2019

2021
2012

2014

2015

2017

2020

2022

2023
2QFY24
2017

2018

2019

2020

2021

2022

2023

Source: Company, Kotak Institutional Equities Source: Company, Kotak Institutional Equities

RoE recovery for PNB is expected in FY2025E, while the others will see RoE recovery in FY2024E
Return on equity for PSU banks under coverage, March fiscal year-ends (%)

SBI BOB Canara Union PNB

20

10

(10)

(20)

(30)
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024E 2025E 2026E

Source: Company, Bloomberg, Kotak Institutional Equities estimates

Banks
India Research
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“Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is
responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies
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views expressed in this report: M B Mahesh, Nischint Chawathe, Ashlesh Sonje, Abhijeet Sakhare, Varun Palacharla, Sidham Jain.”

Ratings and other definitions/identifiers

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BUY. We expect this stock to deliver more than 15% returns over the next 12 months.

ADD. We expect this stock to deliver 5-15% returns over the next 12 months.
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Percentage of companies covered by Kotak Institutional

70%
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The coverage view represents each analyst’s overall fundamental outlook on the Sector. The coverage view will consist of one of the following
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